UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549  FORM 10-Q   x
QUARTERLY
  REPORT UNDER SECTION 13 OR 15(d) OF THE
  SECURITIES
  EXCHANGE ACT OF 1934For the quarterly period ended June
  30, 2006TRANSITION
  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
  SECURITIES EXCHANGE ACT OF 1934 For the transition
period from _________ to _________ Commission file number 1-14762  THE SERVICEMASTER COMPANY(Exact name of registrant as specified in its charter)   Delaware
36-3858106(State or other jurisdiction ofincorporation or organization)
(IRS Employer Identification No.) 3250 Lacey Road, Ste. 600, Downers
Grove, Illinois  60515-1700
(Address of principal executive
offices)                        (Zip
Code) 630-663-2000
(Registrants telephone number, including area code) Indicate by check mark whether the registrant (1) has
filed all reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes x
          No o Indicate by check mark whether the Registrant is a
large accelerated filer, an accelerated filer, or a non-accelerated filer. See
definition of accelerated filer and large accelerated filer in Exchange Act
Rule 12b-2. Large accelerated filer x
Accelerated filer o
Non-accelerated filer o Indicate by check mark whether the registrant is a
shell company (as defined in Exchange Act Rule 12b-2). Yes o
             No x Indicate the number of shares outstanding of each of
the issuers classes of common stock: 290,852,000 shares of common stock on
July 28, 2006.    TABLE OF
CONTENTS

Page
  No.THE
  SERVICEMASTER COMPANY (Registrant) -Part
  I. Financial InformationItem 1:
  Financial Statements (Unaudited)Condensed
  Consolidated Statements of Operations for the three and six months ended June
  30, 2006 and June 30, 2005

3Condensed
  Consolidated Statements of Financial Position  as of June 30, 2006 and December 31, 2005

4Condensed
  Consolidated Statements of Cash Flows for the six months ended June 30, 2006
  and June 30, 2005

5Notes
  to Condensed Consolidated Financial Statements

6Item
  2: Management Discussion and Analysis of Financial  Condition and Results of Operations

18Item
  3: Quantitative and Qualitative Disclosures About Market Risk

30Item
  4: Controls and Procedures

31Part
  II. Other InformationItem
  1: Legal Proceedings

32Item
  1A: Risk Factors

32Item
  2: Unregistered Sales of Equity Securities and Use of Proceeds

32Item
  4: Submission of Matters to a Vote of Security Holders

33Item
  6: Exhibits

34Signature

352

PART I. FINANCIAL INFORMATION
THE SERVICEMASTER COMPANYCondensed Consolidated Statements of Operations (Unaudited)(In thousands, except per share data)

Three Months Ended
  June 30,

Six Months Ended
  June 30,2006

2005

2006

2005Operating Revenue

$
1,024,624

$
970,627

$
1,687,011

$
1,594,387Operating Costs and Expenses:Cost of services rendered and products sold


611,862


570,324


1,046,532


984,195Selling and administrative expenses


263,056


262,005


458,876


444,368Amortization expense


3,325


1,331


5,410


2,483Restructuring charge


6,286





9,838


Total operating costs and expenses


884,529


833,660


1,520,656


1,431,046Operating Income


140,095


136,967


166,355


163,341Non-operating Expense (Income):Interest expense


16,093


14,401


30,523


29,980Interest and investment income,
  net


(1,213
)

(3,226
)

(11,549
)

(12,600
)Minority interest and other expense, net


2,074


2,047


4,123


4,093Income from Continuing Operations
  before Income Taxes


123,141


123,745


143,258


141,868Provision for income taxes


48,395


48,354


56,301


55,441Income from Continuing Operations


74,746


75,391


86,957


86,427Income (loss) from businesses
held pending sale
  and  discontinued operations, net of
  income taxes


2,400


4,410


(24,124
)

3,946Net Income

$
77,146

$
79,801

$
62,833

$
90,373Per Share:Basic Earnings Per Share:Income from continuing operations

$
0.26

$
0.26

$
0.30

$
0. 30Income (loss) from businesses
held pending sale
  and  discontinued operations


0.01


0.02


(0.08
)

0.01Basic earnings per share

$
0.27

$
0.27

$
0.22

$
0.31Shares


290,748


291,634


291,146


291,400Diluted Earnings Per Share:Income from continuing operations

$
0.25

$
0.25

$
0.29

$
0.29Income (loss) from businesses
held pending sale
  and  discontinued operations


0.01


0.01


(0.08
)

0.01Diluted earnings per share

$
0.26

$
0.27

$
0.21

$
0.30Shares


302,728


305,377


295,459


297,254See Notes to
Condensed Consolidated Financial Statements

3

THE
SERVICEMASTER COMPANYCondensed Consolidated Statements of Financial Position
(Unaudited)(In thousands, except per
share data)

As of June 30,2006

As of December 31,2005AssetsCurrent
Assets:Cash and cash
equivalents

$
119,969

$
114,508Marketable securities


107,816


104,807Receivables, less allowance of
$21,948 and
  $17,702, respectively


444,569


309,567Inventories


69,015


60,331Prepaid expenses and other
assets


65,480


23,948Deferred customer acquisition
costs


62,679


40,402Deferred taxes


54,358


35,050Assets of businesses held
pending sale and
  discontinued operations


101,881


135,100Total Current Assets


1,025,767


823,713Property and
Equipment:At cost


403,566


364,503Less: accumulated
depreciation


(228,779
)

(202,676
)Net
  property and equipment


174,787


161,827Other Assets:Goodwill


1,601,143


1,548,070Intangible assets, primarily
trade names, net


248,676


230,343Notes receivable


29,796


30,941Long-term marketable
securities


161,501


147,332Other assets


10,570


9,304Assets of businesses held
pending sale and
  discontinued operations


76,875


77,340Total Assets

$
3,329,115

$
3,028,870Liabilities and
Shareholders EquityCurrent
Liabilities:Accounts payable

$
122,683

$
91,625Accrued liabilities:Payroll and
related expenses


98,628


103,028Self-insured
claims and related expenses


93,003


93,047Income taxes
payable


53,905


30,730Other


110,705


87,984Deferred revenues


488,378


432,741Liabilities of businesses held
pending sale and
  discontinued operations


105,403


97,294Current portion of long-term
debt


20,206


19,222Total Current
Liabilities


1,092,911


955,671Long-Term Debt


783,947


638,928Long-Term
Liabilities:Deferred
  taxes


135,477


113,300Liabilities
of businesses held pending sale and discontinued
  operations


9,287


10,130Other
  long-term obligations


158,507


156,201Total
  Long-Term Liabilities


303,271


279,631Minority
Interest


100,000


100,000Commitments and
ContingenciesShareholders Equity:Common stock $0.01 par value,
authorized
  1,000,000 shares; issued  323,353 and
  321,338 shares, respectively


3,234


3,213Additional paid-in
capital


1,129,216


1,117,388Retained earnings


281,751


282,993Accumulated other comprehensive
income


8,832


7,197Restricted stock (unearned
compensation)





(14,438
)Treasury stock


(374,047
)

(341,713
)Total Shareholders
Equity


1,048,986


1,054,640Total Liabilities and
Shareholders Equity

$
3,329,115

$
3,028,870See Notes to Condensed Consolidated
Financial Statements

4

THE
SERVICEMASTER COMPANYCondensed Consolidated Statements of Cash Flows (Unaudited)(In thousands)

Six Months EndedJune 30,2006

2005Cash and Cash Equivalents at
  January 1

$
114,508

$
256,626Cash Flows from Operating
  Activities from Continuing Operations:Net Income


62,833


90,373Adjustments to
reconcile net income to net cash
  provided from (used for) operating activities:Loss
  (income) from businesses held pending sale and discontinued operations


24,124


(3,946
)Depreciation
expense


22,608


21,954Amortization
  expense


5,410


2,483Change in working capital, net
of acquisitions:Receivables


(81,772
)

(77,264
)Inventories
and other current assets


(67,558
)

(65,469
)Accounts
payable


25,762


30,824Deferred
revenues


48,998


45,230Accrued
liabilities


9,875


25,449Change in tax
accounts:Deferred
income taxes


43,962


46,298Resolution of
income tax audits


(5,036
)

(131,562
)Other,
  net


7,124


6,555Net Cash Provided from (Used
  for) Operating Activities from Continuing Operations


96,330


(9,075
)Cash Flows from Investing
  Activities from Continuing Operations:Property
additions


(26,267
)

(20,457
)Sale of
equipment and other assets


1,104


1,138Business
acquisitions, net of cash acquired


(100,023
)

(19,125
)Notes
receivable, financial investments and
  securities


(15,765
)

(11,507
)Net Cash Used for Investing
  Activities from Continuing Operations


(140,951
)

(49,951
)Cash Flows from Financing
  Activities from Continuing Operations:Borrowings of
debt


698,108


318,242Payments of
debt


(561,106
)

(329,042
)Purchase of
ServiceMaster stock


(44,143
)

(16,979
)Shareholders dividends


(64,075
)

(64,025
)Proceeds from
employee share plans


21,288


12,064Net Cash Provided from (Used
for) Financing
  Activities from Continuing Operations


50,072


(79,740
)Cash Flows from Businesses
Held
  Pending Sale and Discontinued Operations:Cash provided from (used for)
operating
  activities of businesses held pending sale and discontinued operations


(349
)

5,887Cash provided from (used for)
investing
  activities of businesses held pending sale and discontinued operations


359


(1,871
)Net Cash Provided from
  Businesses Held Pending Sale and Discontinued Operations


10


4,016Cash Increase (Decrease)
During
  the Period


5,461


(134,750
)Cash and Cash Equivalents at
  June 30

$
119,969

$
121,876See Notes to Condensed Consolidated
Financial Statements

5

THE SERVICEMASTER COMPANYNOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(UNAUDITED)

Note 1: The condensed consolidated financial
statements include the accounts of The ServiceMaster Company and its
subsidiaries, collectively referred to as the Company. Intercompany
transactions and balances have been eliminated in consolidation. The financial
results as well as the assets and liabilities related to American Residential
Services and American Mechanical Services have been classified as businesses held
pending sale and discontinued operations.

Note 2: The condensed consolidated financial
statements have been prepared by the Company in accordance with accounting
principles generally accepted in the United States (GAAP) and pursuant to the
rules and regulations of the Securities and Exchange Commission. The Company
recommends that the quarterly condensed consolidated financial statements be
read in conjunction with the consolidated financial statements and the notes
thereto included in the Companys latest Annual Report to Shareholders
incorporated in the Form 10-K filed with the Securities and Exchange Commission
for the year ended December 31, 2005 (2005 Annual Report). The condensed
consolidated financial statements reflect all adjustments which are, in the
opinion of management, necessary for the fair presentation of the financial
position, results of operations and cash flows for the interim periods. The
results of operations for any interim period are not necessarily indicative of
the results which might be achieved for a full year.

Note 3: The Company has identified the most
important accounting policies with respect to its financial position and
results of operations. These relate primarily to revenue recognition and the
deferral of customer acquisition costs. The following revenue recognition
policies have not changed since year-end, although the policy discussed below
related to revenue from commercial disaster response and reconstruction
projects has been added as a result of the acquisition in February 2006 of
InStar Services Group (InStar). Revenues from lawn care and pest control
services and liquid and fumigation termite applications are recognized as the
services are provided. Revenues from landscaping services are recognized as
they are earned based upon agreed monthly contract arrangements or when
services are performed for non-contractual arrangements. The Company eradicates
termites through the use of baiting systems, as well as through non-baiting
methods (e.g., fumigation or liquid treatments). Termite eradication services
using baiting systems, as well as home warranty services, frequently are sold
through annual contracts for a one-time, upfront payment. Direct costs of these
contracts (service costs for termite contracts and claim costs for warranty
contracts) are expensed as incurred. The Company recognizes revenue over the
life of these contracts in proportion to the expected direct costs. Those costs
bear a direct relationship to the fulfillment of the Companys obligations
under the contracts and are representative of the relative value provided to
the customer (i.e., the proportional performance method). Home warranty
contract revenue is recognized based on the expected emergence of total claim
costs. The Company regularly reviews its estimates of direct costs for its
termite bait and home warranty contracts and adjusts the estimates when
appropriate. Revenue from the Companys commercial disaster response and
reconstruction projects are recognized using the percentage of completion method
in the ratio that total incurred costs bear to total estimated costs. The
Company has franchise agreements in its TruGreen ChemLawn, Terminix,
ServiceMaster Clean, Merry Maids, AmeriSpec and Furniture Medic businesses.
Franchised revenue (which in the aggregate represents approximately three
percent of consolidated revenue) consists principally of monthly fees based
upon the franchisees customer level revenue. Monthly fee revenue is recognized
when the related customer level revenue is reported by the franchisee and
collectibility is assured. Franchise revenue also includes initial fees
resulting from the sale of a franchise. These fees are fixed and are recognized
as revenue when collectibility is assured and all material services or
conditions relating to the sale have been substantially performed. Franchise
fee profits comprised eight percent and seven percent of the consolidated
operating income, before headquarter overhead and restructuring charges, for
the three months ended June 30, 2006 and 2005, respectively. Franchise fee
profits comprised 11 percent of the consolidated operating income, before
headquarter overhead and restructuring charges, for the six months ended June
30, 2006 and 2005. The

6

portion of
total franchise fee income related to initial fees received from the sale of a
franchise was immaterial to the Companys consolidated financial statements for
all periods.

The Company
had $488 million and $433 million of deferred revenue at June 30, 2006 and
December 31, 2005, respectively, which consist primarily of payments received
for annual contracts relating to home warranty, termite baiting, pest control
and lawn care services. The revenue related to these services is recognized
over the contractual period as the direct costs emerge, such as when the
services are performed or claims are incurred.

Customer
acquisition costs, which are incremental and direct costs of obtaining a
customer, are deferred and amortized over the life of the related contract in
proportion to revenue recognized. These costs include sales commissions and
direct selling costs which can be shown to have resulted in a successful sale.

TruGreen
ChemLawn has significant seasonality in its business. In the winter and early
spring, this business sells a series of lawn applications to customers which
are rendered primarily in March through October (the production season). This
business incurs incremental selling expenses at the beginning of the year that
directly relate to successful sales for which the revenues are recognized in
later quarters. On an interim basis, TruGreen ChemLawn defers these incremental
selling expenses, pre-season advertising costs and annual repairs and
maintenance procedures that are performed primarily in the first quarter. These
costs are deferred and recognized in proportion to the contract revenue over
the production season, and are not deferred beyond the calendar year-end. Other
business segments of the Company also defer, on an interim basis, advertising
costs incurred early in the year. These costs are deferred and recognized
approximately in proportion to revenue over the balance of the year, and are
not deferred beyond the calendar year-end.

The cost of
direct-response advertising at Terminix, consisting primarily of direct-mail
promotions, is capitalized and amortized over its expected period of future
benefits.

The
preparation of the financial statements requires management to make certain
estimates and assumptions required under GAAP which may differ materially from
the actual results. Disclosures in the 2005 Annual Report presented the
significant areas that require the use of managements estimates and discussed
how management formed its judgments. The areas discussed included the allowance
for uncollectible receivables; accruals for self-insured retention limits
related to medical, workers compensation, auto and general liability insurance
claims; accruals for home warranty and termite damage claims; the possible
outcome of outstanding litigation; income tax liabilities and deferred tax
accounts; useful lives for depreciation and amortization expense; and the
valuation of tangible and intangible assets. There have been no other changes
in the significant areas that require estimates or in the underlying
methodologies used in determining the amounts of these associated estimates.

Note 4: The Company carries insurance policies
on insurable risks at levels which it believes to be appropriate, including
workers compensation, auto and general liability risks. The Company has
self-insured retention limits and insured layers of excess insurance coverage
above those limits. Accruals for self-insurance losses and warranty claims in
the American Home Shield business are made based on the Companys claims
experience and actuarial projections. Current activity could differ causing a
change in estimates. The Company has certain liabilities with respect to
existing or potential claims, lawsuits, and other proceedings. The Company
accrues for these liabilities when it is probable that future costs will be
incurred and such costs can be reasonably estimated. Any resulting
adjustments, which could be material, are recorded in the period the
adjustments are identified.

Note 5: The
Company has implemented certain organizational changes focused on increasing
the speed and intensity of executing its strategic initiatives and accelerating
the growth of the Company. In the second quarter, Jonathan P. Ward resigned as
Chairman and Chief Executive Office of the Company and the Company appointed J.
Patrick Spainhour to serve as Chairman and Chief Executive Officer. In

7

addition, earlier this year
the Company launched Project Accelerate, an internal, multi-phase restructuring
project designed to improve the effectiveness and efficiency of all functional
support areas.

Related to these
organizational changes, the Company recorded restructuring charges of $6.3
million in the second quarter of 2006 and $9.8 million for the six months ended
June 30, 2006. The second quarter charge included severance ($4.4 million for
the Chief Executive Officer and $1.3 million for other individuals) and
third-party professional fees and expenses ($.6 million) directly related to
implementing the organizational changes. This charge is reported in the
Restructuring charge line in the Consolidated Statements of Operations and
was recorded in the Other Operations and Headquarters business segment.

Note 6: In
accordance with Statement of Financial Accounting Standards (SFAS) 142,
goodwill and intangible assets that are not amortized are subject to assessment
for impairment by applying a fair-value based test on an annual basis or more
frequently if circumstances indicate a potential impairment. Such circumstances
could include actual earnings being significantly below managements estimates.
The Companys annual assessment date is October 1.

On February 28, 2006, the Company acquired InStar, a leading direct
provider of commercial disaster response and reconstruction services for
approximately $85 million in cash. The results of InStars operations have been
included in the Companys consolidated financial statements since the
acquisition date. The purchase price was allocated to the underlying net assets
acquired, consisting primarily of trade receivables, project costs in excess of
billings and accounts payable and accrued expenses. In addition, the Company
allocated $20 million to customer relationships, project backlog and other
intangible assets that have a weighted-average useful life of approximately
five years. The Company recorded $25 million of goodwill, none of which is
expected to be deductible for tax purposes. In determining this preliminary
allocation of purchase price, the Company utilized the services of third-party
valuation experts. Certain preliminary value allocations are subject to change
during the year as final valuation information is obtained. The remaining
increase in goodwill and intangible assets relates to tuck-in acquisitions
completed throughout the first six months by Terminix and TruGreen ChemLawn.

The table below
summarizes the goodwill and intangible asset activity and balances:

(In
  thousands)

As of
  December 31,
  2005

Additions

Amorti-
  zation

As of
  June 30,
  2006Non-amortizable
  Assets:Goodwill

$
1,548,070

$
53,073

$


$
1,601,143Trade names
  & other


215,493








215,493Amortizable
  Assets:Other
  intangible assets


49,981


23,743





73,724Accumulated
  amortization(1)


(35,131
)




(5,410
)

(40,541
)Net other
  intangibles


14,850


23,743


(5,410
)

33,183Total

$
1,778,413

$
76,816

$
(5,410
)
$
1,849,819(1) Expected amortization
expense for 2006 of approximately $11 million is expected to decline by $1.7
million annually over the next five years.

The table below presents, by segment, the goodwill that is not subject
to amortization:

(In
  thousands)

As of
  June 30,
  2006

As of
  December 31,
  2005TruGreen ChemLawn

$
721,112

$
700,029Terminix


665,835


661,166American Home Shield


85,378


85,526Other Operations & Headquarters


128,818


101,349Total

$
1,601,143

$
1,548,0708

Note 7: Basic
earnings per share are computed by dividing income available to common
stockholders by the weighted-average number of shares outstanding for the
period. The weighted-average common shares for the diluted earnings per share
calculation includes the incremental effect related to outstanding options and
stock appreciation rights (SARS) whose market price is in excess of the grant
price. Shares potentially issuable under convertible securities have been
considered outstanding for purposes of the diluted earnings per share
calculations. In computing diluted earnings per share, the after-tax interest
expense related to convertible securities is added back to net income in the
numerator, while the diluted shares in the denominator include the shares
issuable upon conversion of the securities. Shares potentially issuable under
convertible securities have been considered outstanding for the three months
ended June 30, 2006 and 2005. For the six months ended June 30, 2006 and 2005,
shares potentially issuable under convertible securities have not been
considered outstanding as their inclusion results in a less dilutive
computation. Had the inclusion of convertible securities not resulted in a less
dilutive computation for the six months ended June 30, 2006 and 2005,
incremental shares attributable to the assumed conversion of the debentures
would have increased shares outstanding by 8.0 million shares for both periods
and the after-tax interest expense related to the convertible debentures that
would have been added to net income in the numerator would have been $2.4
million for both periods.

The following
table reconciles both the numerator and the denominator of the basic earnings
per share from continuing operations computation to the numerator and the
denominator of the diluted earnings per share from continuing operations
computation.

(In thousands, except per share data)

Three Months
  Ended June 30, 2006

Three Months
  Ended June 30, 2005Continuing Operations:

Income

Shares

EPS

Income

Shares

EPSBasic earnings per
share

$
74,746


290,748

$
0.26

$
75,391


291,634

$
0.26Effect of dilutive securities,
  net of tax:Options & SARS





3,980








5,743Convertible
Securities


1,214


8,000





1,178


8,000Diluted earnings per
share

$
75,960


302,728

$
0.25

$
76,569


305,377

$
0.25(In thousands, except per share data)

Six Months
  Ended June 30, 2006

Six Months
  Ended June 30, 2005Continuing Operations:

Income

Shares

EPS

Income

Shares

EPSBasic earnings per
share

$
86,957


291,146

$
0.30

$
86,427


291,400

$
0.30Effect of dilutive securities,
  net of tax:Options & SARS





4,313








5,854Diluted earnings per
share

$
86,957


295,459

$
0.29

$
86,427


297,254

$
0.29Note
8: The Company
maintains a shareholder approved incentive plan that allows for the issuance of
equity-based compensation awards, including stock options, stock appreciation
rights, share grants and restricted stock awards. The Company uses treasury
stock and newly issued stock to satisfy equity-based compensation awards. As of
June 30, 2006, there were approximately 31 million Company shares available for
issuance upon the exercise of outstanding employee stock options and stock
appreciation rights and for future grants. Also, as of June 30, 2006, there was
approximately $23 million of total unrecognized compensation expense related to
non-vested share-based compensation arrangements. That cost is expected to be
recognized primarily over the next four years.

Note 9: The Companys stock options and stock
appreciation rights, collectively option(s), are issued at a price not less
than the fair market value on the grant date and expire within 10 years of the
grant date. Certain options may permit the holder to pay the option exercise
price by tendering Company shares that have been owned by the holder without
restriction for an extended period. Options generally vest over a five year
period; however, vesting of certain awards is accelerated provided the
recipient meets certain criteria. For accelerated awards, the vesting period is
shortened within a range of zero to four years.

9

In December 2004, the Financial Accounting Standards
Board issued SFAS 123 (revised 2004), Share-Based Payment (SFAS 123(R)). SFAS
123(R) replaces SFAS 123, Accounting for Stock-Based Compensation (SFAS 123),
and supersedes Accounting Principles Board Opinion 25, Accounting for Stock
Issued to Employees (APB 25). SFAS 123(R) requires that stock options and
share grants be recorded at fair value and this value is recognized as
compensation expense over the vesting period. SFAS 123(R) requires that compensation
expense be recorded for newly issued awards as well as the unvested portion of
previously issued awards that remain outstanding as of the adoption of SFAS
123(R). The Company has adopted the provisions of SFAS 123(R) effective January
1, 2006 using the modified prospective method which requires application of the
rule after January 1, 2006.

Prior to adopting SFAS 123(R), and beginning in 2003,
the Company was using the Prospective Method as permitted under SFAS 148,
Accounting for Stock-Based Compensation  Transition and Disclosure, an
amendment of FASB Statement No. 123, which required the Company to expense the
fair value of new employee option grants awarded subsequent to 2002. Related to
the unvested option awards granted prior to 2003, the adoption of SFAS 123(R)
in 2006 resulted in incremental compensation expense for the six months ended
June 30, 2006 of approximately $1.7 million pretax, $1.0 million after-tax. For
the full year 2006, the Company expects the total incremental compensation
expense related to adopting SFAS 123(R) to be approximately $3.0 million
pretax, or $1.8 million after-tax. Also, effective January 1, 2006, the Company
reclassified within Shareholders Equity the $14.4 million balance of
Restricted stock (unearned compensation) to Additional paid-in capital.

Prior to the adoption of SFAS 123(R), the Company
adjusted option expense related to forfeited options as the forfeitures
occurred. With the adoption of SFAS 123(R), the Company is estimating the
forfeitures that will occur and is recording periodic option expense net of the
estimated forfeitures. The cumulative impact of the change in accounting for
forfeitures was not material to the consolidated financial statements.

The Company uses a lattice-based option valuation
model to value its option awards. Under a lattice-based model, expected
volatilities are based on a term structure of implied volatilities from traded
options on the Companys stock and historical volatility of the Companys
stock. The Company uses historical data to estimate option exercises and
employee terminations within the valuation model. The expected term of options
granted is derived from the output of the option valuation model and represents
the period of time that options granted are expected to be outstanding. The
range of risk-free rates for periods within the contractual life of the options
is based on the U.S. Treasury forward curve rate and uses a term structure.
Options granted to employees during the six months ended June 30, 2006 and 2005
had a weighted average fair value of $2.55 and $2.80, respectively. The
following assumptions were used for options awarded during the six months ended
June 30, 2006 and 2005:

Six Months
  Ended June 30,2006

2005Expected volatility

17.9% - 42.1
%
27.66% - 47.56
%Weighted-average volatility

19.00
%
28.24
%Expected dividends

3.00
%
3.41
%Expected term (in years)

9

6Risk-free rate

4.39% - 4.64
%
2.98% - 4.65
%Weighted-average risk-free rate

4.54
%
4.06
%The following table presents the proforma impact on
continuing operations for the three and six months ended June 30, 2005 of
compensation expense relating to stock option awards as computed under SFAS
123(R):

10

(In thousands,
  except per share data)

Continuing Operations for the
  Three Months Ended
  June 30,
  2005

Continuing Operations for the
  Six Months Ended
  June 30,
  2005Income as reported

$
75,391

$
86,427Add back: Stock-based
compensation expense
included in reported net income, net of related tax effects


598


1,064Deduct: Stock-based
compensation expense
determined under fair-value method, net of related tax effects


(1,403
)

(3,009
)Proforma net income

$
74,586

$
84,482Basic Earnings Per
Share:As
reported

$
0.26

$
0.30Proforma

$
0.26

$
0.29Diluted Earnings Per
Share:As
reported

$
0.25

$
0.29Proforma

$
0.25

$
0.28Total pretax option expense and income tax benefits
recognized was approximately $1.7 million and $.7 million, respectively for the
three months ended June 30, 2006 and $3.3 million and $1.3 million,
respectively, for the six months ended June 30, 2006.

A summary of option activity as of June 30, 2006 and
changes during the six months then ended is presented below:

Shares

Weighted Avg.
  Exercise Price

Remaining
  Contractual
  Term

Aggregate
  Intrinsic value
  (in thousands)Outstanding at December 31,
  2005


29,508,273

$
12.96Granted to employees


2,130,350

$
12.45Exercised


(1,928,215
)
$
9.62Terminated or resigned


(796,199
)
$
16.24Total outstanding, June 30,
  2006


28,914,209

$
13.06


4.0

$
3,288Total exercisable, June 30,
  2006


22,156,477

$
13.35


2.9

$
2,832During the six months ended June 30, 2006 and 2005,
the total intrinsic value of awards exercised was approximately $6.1 million
and $2.7 million, respectively. The aggregate intrinsic value of outstanding
and exercisable awards was $3.3 million and $2.8 million, respectively at June
30, 2006 and $57.5 million and $42.5 million, respectively at June 30, 2005.
The cash received from the exercise of options was approximately $18.2 million
for the six months ended June 30, 2006.

The following table summarizes the range of exercise
prices and the weighted average remaining contractual life of the options
outstanding and the range of exercise prices for the options exercisable at
June 30, 2006:

Range of
  Exercise Prices

Number
  Outstanding
  at 6/30/06

Weighted
  Average
  Remaining
  Contractual
  Term

Weighted
  Average
  Exercise Price

Number
  Exercisable
  at 6/30/06

Weighted
  Average
  Exercise Price$  8.40  10.78


9,471,539


4 Years

$
10.13


7,606,577

$
10.09$10.80  15.94


13,762,348


4 Years

$
12.51


8,869,578

$
12.35$16.12  22.33


5,489,875


2 Years

$
18.18


5,489,875

$
18.18$27.20  77.56


190,447


1 Year

$
50.28


190,447

$
50.28$  8.40  77.56


28,914,209


4.0 Years

$
13.06


22,156,477

$
13.35The options priced at $77.56 are options assumed by
the Company as a result of business acquisitions.

11

Note 10:
The Companys share grants and restricted stock awards have a general vesting
period of five years and are restricted as to the sale or transfer of the
shares prior to vesting. Restricted stock awards are non-transferable and
subject to forfeiture if the holder does not remain continuously employed by
the Company during the vesting period, or, if the restricted stock is subject
to performance measures, if those performance measures are not attained. The
fair value of the restricted stock awards is equal to the value of the
Companys stock on the date of grant. The Company includes the vested and
unvested portions of the restricted stock awards in shares outstanding in the
denominator of its earnings per share calculations.

Restricted stock awards granted to employees during
the six months ended June 30, 2006 and 2005 have a weighted average fair value
of $12.31 and $13.38, respectively. A summary of the share grant and restricted
stock activity during the six months ended June 30, 2006 is summarized in the
table below:

Shares

Weighted Average
  Grant-date
  Fair ValueOutstanding at December 31,
  2005


1,582,877

$ 12.09Granted to
employees


560,990

$ 12.31Exercised


(308,409
)
$ 11.80Terminated or
resigned


(59,841
)
$ 11.82Total outstanding, June 30,
  2006


1,775,617

$ 12.23Total pretax share grant and restricted stock
compensation expense for the six months ended June 30, 2006 and 2005 was
approximately $2.1 million and $2.5 million, respectively, and the income tax
benefits recognized for these awards was approximately $.9 million and $1.0
million, respectively.

Note 11:
In the Condensed Consolidated Statements of Cash Flows, the caption Cash and
Cash Equivalents includes investments in short-term, highly-liquid securities
having a maturity of three months or less. Supplemental information relating to
the Condensed Consolidated Statements of Cash Flows for the six months ended
June 30, 2006 and 2005 is presented in the following table:

(in thousands)Cash paid for
  or (received from):

2006

2005Interest expense

$
28,300

$
30,167Interest and investment income


(13,253
)

(10,240
)Income taxes, net of refunds


17,765


139,777The increase in cash received from interest and
investment income primarily reflects a higher level of investment income and
gains realized on the growing investment portfolio at American Home Shield.
Cash paid for income taxes decreased in 2006 as a result of $132 million of
taxes paid last year to the Internal Revenue Service (IRS) and various states
pursuant to the Companys agreement with the IRS that was reached in January
2005.

Note 12:
Total comprehensive income was $76 million and $79 million for the three months
ended June 30, 2006 and 2005 respectively, and $64 million and $88 million for
the six months ended June 30, 2006 and 2005, respectively. Total comprehensive
income primarily includes net income, changes in unrealized gains and losses on
marketable securities and foreign currency translation balances.

Note 13:
The Company has an agreement to provide for the ongoing revolving sale of a
designated pool of accounts receivable of TruGreen ChemLawn and Terminix to a
wholly owned, bankruptcy-remote subsidiary, ServiceMaster Funding LLC.
ServiceMaster Funding LLC has entered into an agreement to transfer, on a
revolving basis, an undivided percentage ownership interest in a pool of accounts
receivable to unrelated third party purchasers. ServiceMaster Funding LLC
retains an undivided percentage interest in the pool of accounts receivable and
bad debt losses for the entire pool are allocated first to this retained
interest. During the six months ended June 30, 2006 and 2005, there were no

12

receivables sold to third parties under this
agreement. However, the Company may sell its receivables in the future, which
would provide an alternative funding source. The agreement is a 364-day
facility that is renewable at the option of the purchasers. The Company may
sell up to $70 million of its receivables to these purchasers and therefore has
immediate access to cash proceeds from these sales. The amount of the eligible
receivables varies during the year based on seasonality of the business and
will, at times, limit the amount available to the Company.

Note 14: Total
debt was $804 million at June 30, 2006, approximately $146 million
above the level at December 31, 2005. The increase in debt reflects the
acquisition of InStar and normal seasonal working capital requirements.
Approximately 64 percent of the Companys debt matures beyond five years and
53 percent
beyond fifteen years. The Companys next significant debt maturity is not until
2007.

Note 15:
The financial statement caption businesses held pending sale and discontinued
operations includes American Residential Services (ARS) and American
Mechanical Services (AMS). The ARS/AMS operations provide heating, ventilation,
air conditioning (HVAC), plumbing and electrical installation and repair. In
the first quarter of 2006, the Company recorded a $25 million after-tax
provision for expected losses on the disposition of certain ARS/AMS properties.
Under generally accepted accounting principles, an estimated impairment loss
must be recognized when deemed probable; while potential gains must be deferred
until the sales actually close. Subsequent to June 30, 2006, the Company
completed sales of the AMS business to members of the senior AMS management team.
The Company is currently engaged in detailed negotiations to sell the ARS
business in a single transaction.

The results of businesses held pending sale and
discontinued operations are as follows:

Three months ended June 30,(In
  thousands, except per share data)

2006

2005Revenue

$
199,236

$
203,485Operating income

$
3,961

$
7,291Income tax provision


1,561


2,881Income from businesses held
pending sale and
  discontinued operations

$
2,400

$
4,410Per diluted share income from
businesses held pending
  sale and discontinued operations

$
0.01

$
0.01Six months ended June 30,(In
  thousands, except per share data)

2006

2005Revenue

$
377,434

$
362,034Operating income

$
1,389

$
6,528Impairment charge
(pretax)


(42,000
)

Income tax provision
(benefit)


(16,487
)

2,582Income (loss) from businesses
held pending sale and
  discontinued operations

$
(24,124
)
$
3,946Per diluted share income (loss)
from businesses held
  pending sale and discontinued operations

$
(0.08
)
$
0.01The following table summarizes the activity during the
six months ended June 30, 2006 for the remaining liabilities from previously
discontinued operations and does not include the liabilities of businesses held
pending sale (ARS/AMS).

13

(In thousands)

Balance at
  December 31,
  2005

Cash
  Payments
  or Other

Income/
  (Expense)

Balance at
  June 30,
  2006Remaining
  liabilities from discontinued operations

$
16,036

$
2,041

$
(1,990
)
$
15,985Note
16: In the ordinary
course, the Company is subject to review by domestic and foreign taxing
authorities, including the IRS. As previously disclosed, the U.S. federal tax
returns filed by the Company through the 2004 return have already been reviewed
by the IRS. The Company paid $5 million primarily in the first quarter of 2006
relating to the resolution of the 2003 and 2004 audits. In the first quarter of
2005, the IRS commenced the audit of the Companys tax return for 2005 and, in
the first quarter of 2006, the IRS commenced the audit of the Companys tax
return for 2006. As with any review of this nature, the outcomes of the IRS
examinations are not known at this time.

Note 17:
In July 2006, the Financial Accounting Standards Board issued FASB Interpretation
No. 48 Accounting for Uncertain Tax Positions (FIN 48). FIN 48 provides
guidance on the accounting for and disclosure of tax positions accounted for in
accordance with Statement of Financial Accounting Standards No. 109. FIN 48
requires that the effects of a tax position be initially recognized when it is
more likely than not (which is defined as a greater than 50 percent chance)
that the position will be sustained upon examination by the taxing authorities.
In addition, FIN 48 requires additional disclosures regarding tax positions.
FIN 48 is effective beginning January 1, 2007. The Company is presently
assessing the impact of FIN 48 to the
Companys consolidated financial position, results of operations and cash
flows.

Note 18:
The business of the Company is conducted through five operating segments:
TruGreen ChemLawn, TruGreen LandCare, Terminix, American Home Shield and Other
Operations and Headquarters. The TruGreen ChemLawn segment provides residential
and commercial lawn care services. The TruGreen LandCare segment provides
landscape maintenance services primarily to commercial customers. The Terminix
segment provides termite and pest control services to residential and
commercial customers. The American Home Shield segment provides home warranties
to consumers that cover heating, ventilation and air conditioning (HVAC),
plumbing and other home systems and appliances. This segment also includes home
inspection services provided by AmeriSpec. The Other Operations and
Headquarters segment includes InStar Services Group, a direct provider of
commercial disaster response and reconstruction services as well as the
franchised and Company-owned operations of ServiceMaster Clean, Furniture Medic
and Merry Maids, which provide disaster restoration, commercial cleaning,
carpet and upholstery cleaning, furniture repair and maid services. The Other
Operations and Headquarters segment also includes the Companys headquarters
operations, which provide various technology, marketing, finance, legal and
other support services to the business units. Segment information is presented
in the following table.

14

(In thousands)

Three Months
  Ended June 30,
  2006

Three Months
  Ended June 30,
  2005

Six Months
  Ended June 30,
  2006

Six Months
  Ended June 30,
  2005Operating Revenue:TruGreen
ChemLawn

$
357,430

$
357,483

$
494,694

$
480,819TruGreen
LandCare


118,932


120,300


217,853


219,946Terminix


307,735


305,616


561,274


553,361American Home
Shield


159,466


144,286


276,396


255,296Other
Operations and Headquarters


81,061


42,942


136,794


84,965Total
  Operating Revenue

$
1,024,624

$
970,627

$
1,687,011

$
1,594,387Operating Income
(Loss)(1):TruGreen
ChemLawn

$
63,798

$
70,937

$
60,975

$
63,630TruGreen
LandCare


(2,589
)

(2,334
)

(4,407
)

(2,635
)Terminix


59,754


57,246


93,216


88,011American Home
Shield


24,465


23,678


33,598


37,951Other
Operations and Headquarters


(5,333
)

(12,560
)

(17,027
)

(23,616
)Total Operating
Income

$
140,095

$
136,967

$
166,355

$
163,341(1)
Presented
  below is a reconciliation of segment operating income to income from
  continuing operations before income taxes.(In thousands)

Three Months
  Ended June 30,
  2006

Three Months
  Ended June 30,
  2005

Six Months
  Ended June 30,
  2006

Six Months
  Ended June 30,
  2005Segment Operating
Income

$
140,095

$
136,967

$
166,355

$
163,341Non-operating expense
(income):Interest
expense


16,093


14,401


30,523


29,980Interest and
investment income, net


(1,213
)

(3,226
)

(11,549
)

(12,600
)Minority
interest and other expense, net


2,074


2,047


4,123


4,093Income from
Continuing Operations before Income
  Taxes

$
123,141

$
123,745

$
143,258

$
141,868The combined operations of
ServiceMaster Clean, InStar and Merry Maids, which are included in the Other
Operations and Headquarters segment, comprised approximately eight percent and
four percent of the consolidated revenue for the three months ended June 30,
2006 and 2005, respectively, and eight percent and five percent of the
consolidated revenue for the six months ended June 30, 2006 and 2005,
respectively. These operations comprised approximately nine percent and eight
percent of the consolidated operating income, before headquarter overheads and
restructuring charges, for the three months ended June 30, 2006 and 2005,
respectively, and 13 percent and 11 percent of the consolidated operating
income, before headquarter overheads and restructuring charges, for the six
months ended June 30, 2006 and 2005, respectively.

15

(In thousands)

As of
  June 30, 2006

As of
  December 31, 2005Identifiable Assets:TruGreen
ChemLawn

$
1,008,200

$
885,153TruGreen
LandCare


97,424


92,694Terminix


883,866


862,270American Home
Shield


565,907


530,486Other
Operations & Headquarters


773,718


658,267Total Identifiable
Assets

$
3,329,115

$
3,028,870(In thousands)

As of
  June 30, 2006

As of
  June 30, 2005Capital Employed:
(2)TruGreen
ChemLawn

$
899,948

$
860,508TruGreen
LandCare


42,279


39,887Terminix


645,985


629,728American Home
Shield


230,808


193,110American
  Home Shield without Cash and marketable securities (2)


(73,531
)

(81,358
)Other
Operations & Headquarters


134,119


197,066Total Capital
Employed

$
1,953,139

$
1,920,299(2)
Capital employed is a
  non-U.S. GAAP measure that is defined as the segments total assets less
  liabilities, exclusive of debt balances. The Company believes this
  information is useful to investors in helping them compute return on capital
  measures and therefore better understand the performance of the Companys
  business segments. The calculation of capital employed for the American Home
  Shield segment includes approximately $304 million and $274 million of cash
  and marketable securities at June 30, 2006 and 2005, respectively. The
  investment income and realized gains/losses on these assets are reported
  below operating income in non-operating income/expense. In order to
  facilitate the comparison of return on invested capital for the American Home
  Shield segment, the Company has also presented capital employed for this
  segment excluding cash and marketable securities. The negative capital
  employed balances primarily result from deferred revenue and amounts payable
  to subcontractors. Presented below is a reconciliation of total segment
  capital employed to the most comparable U.S. GAAP measure.(In thousands)

As of
  June 30, 2006

As of
  June 30, 2005Total Assets

$
3,329,115

$
3,166,424Less:Current
liabilities, excluding current portion of long-term debt


1,072,705


968,020Long-term
liabilities


303,271


278,105Total Capital
Employed

$
1,953,139

$
1,920,299Note 19:
In the ordinary course of conducting its business activities, the Company
becomes involved in judicial, administrative and regulatory proceedings involving
both private parties and governmental authorities. These proceedings include
general and commercial liability actions and a small number of environmental
proceedings. The Company does not expect any of these proceedings to have a
material adverse effect on its Consolidated Financial Statements.

16

The Companys InStar
Services Group (InStar) subsidiary has received a federal grand jury subpoena
arising from an investigation being conducted by the United States Attorneys
Office in the Southern District of Florida and the Environmental Protection
Agency. The investigation relates to potential violations of the Clean Air Act
by InStar for actions by that subsidiary prior to its acquisition by the
Company on February 28, 2006. The subpoena was received after the Company
completed the InStar acquisition.

At this stage, the Company
is unable to predict what, if any, actions may be taken by the U.S. Attorneys
Office or the Environmental Protection Agency or to assess what penalties
ultimately may be sought or what the collateral consequences of any such
actions would be. Nevertheless, it is possible that the federal investigation,
any resulting prosecution of InStar and any collateral consequences arising
from that prosecution could adversely affect InStars on-going business in
Florida and elsewhere. InStar is cooperating in the investigation, which may
continue for some time. The activities of the subsidiary that gave rise to the
investigation ceased upon notice of the investigation and InStar has adopted measures
designed to prevent any re-occurrence.

Based upon currently
available information about this matter, the Company believes that any
disruption to the InStar business arising from the investigation and possible
prosecution will not have a material effect on the Companys financial
condition or results of operations.

17

MANAGEMENT
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS

RESULTS OF OPERATIONS

BUSINESS OVERVIEW AND OUTLOOK FOR 2006

ServiceMaster (the Company) is focusing its efforts
in three key areas: (1) Improving the Customer Experience  The Company
believes that its single greatest opportunity is to enhance existing customer
satisfaction and retention. The Company has implemented programs to capture
this opportunity by improving communications with customers, consistency of
service quality and problem resolution procedures. (2) Increasing Leverage and
Integration  Progress continues to be made on streamlining the basic workings
of the Company. As more fully discussed below, the Company launched Project
Accelerate in order to improve the effectiveness and efficiency of its
functional support areas. The Company believes there are additional
opportunities within its branch and regional operations to better leverage the
established infrastructure and reap further technology-aided productivity
gains. (3) Expanding the Companys Growth Opportunities  Even though the
Company has a strong footprint in many of its businesses, the Company believes
there is significant opportunity to grow the business by moving into adjacent
and underserved areas through new branches, service or sales satellites or
through tuck-in acquisitions, and by continuing to expand its sales channels
and methods.

Outlook

For 2006, the Company expects revenue growth to be in
the mid-single digit range and that earnings per share from continuing
operations before restructuring charges will grow in the low double digits,
with a relatively strong fourth quarter providing a good foundation as
the Company enters 2007. While existing uncertainties in the general economy
reduce visibility somewhat, the Company continues to believe that intensified focus on
customer satisfaction and retention, positive effects from the recent InStar
acquisition, and increased savings from Project Accelerate and other related
cost control efforts will enable it to achieve its earnings forecast for the
year.

SECOND QUARTER 2006 COMPARED TO 2005

The Company reported second quarter 2006 revenue of
$1.0 billion, a six percent increase compared to 2005. Approximately four
percent of the increase in revenue resulted from acquisitions, primarily InStar
Services Group (InStar), which was acquired at the end of February 2006. Total
diluted earnings per share (i.e., from both continuing operations and
businesses held pending sale and discontinued operations) were $.26 compared to
$.27 in 2005. Diluted earnings per share from continuing operations were $.25,
consistent with 2005. Operating income for the second quarter was $140 million
compared to $137 million in the prior year.

The Company has implemented certain organizational
changes focused on increasing the speed and intensity of executing its
strategic initiatives and accelerating the growth of the Company. In the second
quarter, Jonathan P. Ward resigned as Chairman and Chief Executive Officer of
the Company and the Company appointed J. Patrick Spainhour to serve as Chairman
and Chief Executive Officer. Earlier this year, the Company also launched
Project Accelerate, an internal, multi-phase restructuring project designed to
improve the effectiveness and efficiency of all functional support areas.
Related to these organizational changes, the Company recorded a restructuring
charge of $6.3 million in the second quarter of 2006. This charge is reported
in the Restructuring charge line in the Consolidated Statements of Operations
and was recorded in the Other Operations and Headquarters business segment. The
Company expects that all charges will be incurred and recognized prior to the
end of the year, and should approximate $12 to $13 million in total.

18

Operating income was favorably impacted by continued
favorable trending of prior year insurance claims, lower support costs and
savings from Project Accelerate, the first time inclusion of operating profits
from the InStar acquisition (modestly accretive after acquisition interest for
the second quarter) and improved operating income margins at Terminix
(supported by lower material costs and termite damage claim expense). These
factors were offset in part by the restructuring charge, lower profits at
TruGreen ChemLawn due in part to the timing of lawn care production, which was
accelerated into the first quarter this year due to more favorable weather
conditions, than had existed in 2005, and increased fuel and health insurance
costs throughout the enterprise.

The
Company was able to offset unusually rapid increases in fuel, health care and
interest costs with its focus on controllable costs. The Company has maintained
its momentum in driving down safety-related costs, the impact of which is most
prominently manifested in continuing favorable trends of prior year claims. In
total, safety-related costs declined approximately $.02 per share for the first
six months. Safety-related costs are expected to be relatively flat in the
second half of the year, consistent with the very strong results achieved in
the comparable period of 2005. The Company believes there is plenty of
opportunity for further improvement in this area and is still well short of its
long term safety goals.

The
Company is on track to meet or exceed the previously anticipated savings from
Project Accelerate, an internal, multi-phase restructuring project designed to
realign the Companys cost structure in light of divestitures, create a more
effective and efficient functional support structure and provide savings and
funds for reinvestment in growth initiatives. The design phase of the project
was completed at the end of the first quarter 2006, with implementation staged
mostly over the balance of this year. The Company remains confident that it will
ultimately realize pretax savings, net of reinvestments, in the $25 million to
$35 million range, or $.05 to $.07 per share, to be fully realized in 2008. The
Company expects to realize these savings progressively with $.02 per share of
net savings in 2006, mostly in the second half of the year, $.04 to $.05 in
2007, and the balance in 2008. Most of these savings will benefit the selling,
general and administrative line in the statement of operations, although some
savings, such as those from safety and sourcing initiatives, will benefit cost
of sales. The Company expects to pay the majority of the restructuring costs by
the end of 2006.

With
respect to fuel, the Companys fleet, which consumes roughly 30 million gallons
annually, continues to be negatively impacted by significant increases in oil
prices. Although the Company hedges approximately two-thirds of its estimated
annual fuel usage, fuel costs net of the hedges increased approximately $8
million for the six months. For the full year, if pump prices stay at current
levels, the Company expects increased fuel expense over last year of almost
$.03 per share. The Company is continuing its efforts to reduce fuel
consumption by implementing GPS and routing and scheduling technologies that
will help tighten routes and reduce drive times.

Health
care costs continue to experience strong inflationary pressures, and this is
expected to continue. As previously disclosed, the Company is making an
additional investment of approximately $.01 per share in employee health care
benefits in 2006 as part of its efforts to further enhance its position as an
employer of choice. For the first six months of the year, the Company
experienced an increase of approximately $.01 per share in healthcare and
related costs, with an incremental impact of $.03 per share expected for the
year as a whole.

Sharp increases in short
term interest rates have impacted the Companys businesses at the operating
income level by virtue of their effects on floating rate-based fleet and occupancy
leases. The Company estimates that the increases in interest rates totaled an
incremental $3 million of lease expense in the first half of the year and, at
current rates, this would adversely impact full year results by $6 million.

Cost of services rendered and products sold increased
seven percent for the second quarter. As a percentage of revenue, these costs
increased to 59.7 percent in 2006 from 58.8 percent in 2005, due in part to
relatively less labor efficiency in the second quarter resulting from the
acceleration of lawn care

19

production into the first quarter this year, increased
contract claim costs at American Home Shield due to hotter weather and
increased fuel costs throughout the enterprise. Selling and administrative
expenses were comparable to prior year levels. As a percentage of revenue,
these costs decreased to 25.7 percent in 2006 from 27.0 percent in 2005,
primarily reflecting lower support costs and savings from Project Accelerate
and a decrease in compensation expense related to an employee deferred
compensation trust for which there is a corresponding and offsetting decrease
in investment income within non-operating expense/(income).

Net non-operating expenses increased approximately $4
million in the second quarter, primarily reflecting a decline in the market
value of investments within the employee deferred compensation trust described
above.

Segment Reviews for the Second Quarter 2006
Compared to 2005

The
following business segment reviews should be read in conjunction with the
required footnote disclosures presented in the Notes to the Condensed
Consolidated Financial Statements. This disclosure provides a reconciliation of
segment operating income to income from continuing operations before income taxes,
with net non-operating expenses as the only reconciling item. The Companys
business segment reviews include discussions of capital employed, which is a non-U.S. GAAP measure that is defined as
the segments total assets less
liabilities, exclusive of debt balances. The Company believes this information
is useful to investors in helping them compute return on capital measures and
therefore better understand the performance of the Companys business segments.
The Notes to the Condensed Consolidated
Financial Statements also include a reconciliation of segment capital employed
to its most comparable U.S. GAAP measure.

The TruGreen ChemLawn segment, which provides lawn
care services to residential and commercial customers, reported revenues of
$357 million, comparable to the prior year. The segment reported operating
income of $64 million compared to $71 million in 2005. The second quarter
results include a strong increase in revenue from supplemental services and
growth from commercial accounts, offset by a decline in residential services
revenue. The decline in residential services revenue was partially attributable
to differences in the timing of production, with a greater percentage of the
year-to-date total accelerated into the first quarter this year due to more
favorable weather conditions. In addition, customer counts were three percent
below the prior year. The primary challenge impacting customer counts has been
declines in telemarketing sales due to the continued expansion of Do Not Call
lists and caller ID mechanisms. This has more than offset growth in sales from
newer channels, including direct mail and neighborhood programs. As the Company
looks to the future, its starting point will have significantly less reliance
on telemarketing, which now represents approximately 45 percent of new sales,
versus more than 90 percent a few years ago. In addition, the Company believes
it can meaningfully expand its recent growth in newer sales channels by
increasing its emphasis in these areas, and by better leveraging people
expertise and other best practices that exist within the organization. The
second quarter decline in operating income was due in part to the previously
discussed timing of production, as well as increased fuel prices and health
insurance costs. Capital employed in the TruGreen ChemLawn segment increased
five percent, primarily reflecting the impact of tuck-in acquisitions.

The TruGreen LandCare segment, which provides
landscape maintenance services primarily to commercial customers, reported a
one percent decrease in second quarter revenue to $119 million compared to $120
million in 2005, and an operating loss of ($2.6) million compared to ($2.3)
million in 2005. Base contract maintenance revenue decreased one percent for
the quarter, while revenue from enhancement sales (e.g., add-on services such
as seasonal flower plantings, mulching, etc.) was comparable to the prior year.
Recent investments in the size, caliber and training of the sales team at
TruGreen LandCare have led to an improvement in the relative size and quality
of sales proposals issued and outstanding. This, combined with improved
retention, is expected to lead to increasing base contract maintenance revenues
beginning in the fourth quarter. The increase in the second quarter operating
loss

20

reflects the decline in revenue and the impact of
increased fuel prices, partially offset by favorable trending of insurance
costs.  Capital employed in the TruGreen
LandCare segment increased six percent.

The Terminix segment, which includes termite and pest
control services, reported a one percent increase in second quarter revenue to
$308 million, compared to $306 million in 2005. Operating income increased four
percent to $60 million compared to $57 million in 2005.  Terminixs overall revenue growth for the
second quarter was impacted by offsetting results on the termite side of the
business.  Improved pricing on termite
contract renewals, combined with a shift in product mix,
supported growth in termite renewal revenues, despite a modest decline in
customer retention.  Revenue from
initial termite applications (termite completions) declined in the second
quarter and was adversely impacted by a weak annual termite swarm season in
most parts of the country.  Despite the
weak swarm activity, which the Company believes was an industry-wide
phenomenon, the Company did achieve a one percent increase in unit sales of
termite completions.   Because of the
weak swarm, the inflow of sales leads declined significantly in most regions of
the country.  However, the Company was
able to mitigate the lead flow decline through proactive sales efforts and
improved training and techniques, resulting in substantially increased sales
conversion rates.  The Company believes
that it has maintained or improved its market share, despite the poor
swarm.  Second quarter pest control
revenue increased four percent, supported by solid growth in both residential
and commercial unit sales, improved customer retention and the impact of
acquisitions.  Terminix achieved solid
profit growth despite higher fuel and health insurance costs.  This improvement primarily reflects lower
termite material costs and reduced termite damage claims expense driven by
product and process improvements.
Capital employed in the Terminix segment increased three percent,
reflecting the impact of tuck-in acquisitions.

The American Home Shield segment, which provides home
warranties to consumers that cover heating, ventilation and air conditioning
(HVAC), plumbing and other home systems and appliances, reported an 11 percent
increase in revenue to $159 million from $144 million in 2005 and a three
percent increase in operating income to $24 million.  Warranty contract sales and renewals, which are reported as
earned revenue over the subsequent twelve-month contract period, increased
seven percent for the quarter.  A
strong, double-digit increase in customer renewals, which are American Home
Shields largest source of revenue, was supported by a larger base of renewable
customers and continued sharp improvements in customer retention.  Real estate sales, American Home Shields
second largest channel that comprises approximately 30 percent of the total
annual contracts written, decreased in the second quarter, as home listings and
closings were impacted by a weakening home resale market.  In July, the Company signed a
significant agreement with a large real estate brokerage firm.  This agreement is expected to begin
generating sales in the fourth quarter.
Overall, the Company anticipates significant incremental sales in the
first full year of the agreement, or approximately $40 million in annualized
revenue.  Second quarter sales in the
direct to consumer channel declined, resulting from the timing of certain
direct mail campaigns, as well as lower response rates on certain programs,
with stronger sales expected in the third and fourth quarters.  The growth in operating income reflects the
impact of the growth in revenue, offset in part by higher contract claim costs
resulting from hotter weather this year, as well as incremental planned
investments in initiatives to improve service quality and customer retention.

Capital employed in the American Home Shield segment
increased 20 percent, primarily reflecting a higher level of cash and marketable
securities due to the growth in the business and improved market
performance.  Capital employed at
American Home Shield, which totaled $231 million and $193 million at June 30,
2006 and June 30, 2005, respectively, includes $304 million and $274 million of
cash, short-term and long-term marketable securities at those dates.  The investment income and realized
gains/losses on these assets are reported as non-operating income/expense.

The Other Operations and Headquarters segment includes
the operations of ServiceMaster Clean, InStar and Merry Maids as well as the
Companys headquarters functions.
Revenue in this segment increased to $81 million from $43 million in
2005.  Revenues from InStar (which was
acquired on February 28, 2006) were $32 million in the second quarter.  The ServiceMaster Clean and Merry Maids
franchise operations

21

reported a combined increase in second quarter revenue
of 14 percent, driven by continued strong growth in disaster restoration and
solid internal growth in residential maid service.

The Other Operations and Headquarters segment
operating loss for the quarter was ($5) million compared with ($13) million in
2005.  Included in the second quarter
2006 operating loss is the restructuring charge of $6 million.  Excluding the restructuring charge, the
segment operating loss improved by $14 million in the period reflecting
favorable trending of prior year insurance claims, lower support costs and
savings from Project Accelerate, lower compensation expense related to the
previously discussed deferred employee compensation trust and profits from the
first-time inclusion of operating profits from InStar.  Capital employed in this segment decreased,
primarily reflecting the realization of the annual tax benefit associated with
the amortization of tax intangible assets that will continue through 2012.

SIX MONTHS ENDED JUNE 30, 2006 COMPARED TO 2005

The Company reported revenue of $1.7 billion for the
six months ended June 30, 2006, a six percent increase compared to 2005, with
approximately two percent of the revenue growth coming from organic
sources.  Total diluted earnings per
share (continuing operations and businesses held pending sale and discontinued
operations) were $.21 compared to $.30 in 2005.  In the first quarter of 2006, the Company recorded a non-cash
charge of $25 million after-tax ($.08 per diluted share) for expected losses on
the disposition of certain ARS/AMS properties held pending sale.  This charge is included in the loss from
businesses held pending sale and discontinued operations.

Diluted earnings per share from continuing operations
were $.29, consistent with 2005.
Operating income for the six months was $166 million compared to $163
million in the prior year.  As more
fully described in the second quarter comparison, the six months results for
2006 include a $9.8 million restructuring charge related to organizational
changes implemented at the Company.  For
the six months, the growth in operating income was supported by continued
favorable trending of prior year insurance claims, improved profits at
Terminix, the first-time inclusion of operating profits from the InStar
acquisition and lower support costs and savings from Project Accelerate.  These factors were partially offset by the
restructuring charge and lower profits in several business segments, which are
more fully discussed in the segment reviews.

Cost of services rendered and products sold increased
six percent for the six months and increased as a percentage of revenue to 62.0
percent in 2006 from 61.7 percent in 2005, primarily reflecting the impact of
fuel and other factor cost increases throughout the enterprise.  Selling and administrative expenses
increased three percent for the six months. As a percentage of revenue, these
costs decreased to 27.2 percent in 2006 from 27.9 percent in 2005, primarily
reflecting improved sales labor efficiency at Terminix and lower support costs
and savings from Project Accelerate.

Net non-operating expenses increased approximately
$1.5 million for the six months, primarily reflecting a decline in the market
value of investments within the employee deferred compensation trust.

22

Key
Performance Indicators

The table below presents selected metrics related to
customer counts and customer retention for the three largest profit businesses
in the Company. These measures are presented on a rolling, twelve-month basis
in order to avoid seasonal anomalies.

Key Performance Indicators
  As of June 30,2006

2005TruGreen ChemLawn-Growth in Full
Program Contracts


-3
%

2
%Customer
Retention Rate


65.4
%

66.4
%Terminix -Growth in Pest
Control Customers


3
%

4
%Pest Control
Customer Retention Rate


77.9
%

77.3
%Growth in
Termite Customers


-1
%

1
%Termite
Customer Retention Rate


87.3
%

88.0
%American Home Shield -Growth in
Warranty Contracts


2
%

5
%Customer
Retention Rate


57.9
%

55.9
%Segment Reviews for the Six Months Ended
June 30, 2006 Compared to 2005

As discussed in the second quarter comparison, the
following business segment reviews should be read in conjunction with the
required footnote disclosures presented in the Notes to the Condensed
Consolidated Financial Statements.

For the six months, the TruGreen ChemLawn segment
reported a three percent increase in revenue to $495 million compared to $481
million in 2005 and operating income of $61 million compared to $64 million in
2005.  The increase in revenue reflects
improved price realization, combined with increases in supplemental services
and commercial revenues.  Year-to-date,
the Company has realized a two to three percent increase in average prices and
is selectively targeting opportunities to further improve price realization in
the second half of the year.  Partially
offsetting these sources of growth was a three percent reduction in customer
counts that primarily resulted from a net reduction in new sales.  During the first half of 2006, sales from
direct mail and other channels increased seven percent; however this growth was
more than offset by a sharp decline in telemarketing sales.  Customer retention for the rolling, twelve
months ended June 30 declined 100 basis points; however this is a sharp
improvement from the 250 basis point decrease that existed at the end of the
first quarter.  The Company remains
confident that it will end the year with net gains in customer retention.  Over the last thirteen weeks, customer
cancellations have been less than prior year levels, with customers responding
favorably to the Companys expanded retention efforts.  These include comprehensive annual lawn
quality assessments, faster response standards and satisfaction follow-up calls
on all re-services, and improved customer communication and problem resolution
procedures.  Operating income results
for the six months were adversely impacted by substantially higher fuel prices
and health insurance costs.

The TruGreen LandCare segment reported a one percent
decrease in revenue for the six months to $218 million compared to $220 million
in 2005, and an operating loss of ($4.4) million compared to ($2.6) million in
2005.   The decline in revenue for the
first half of the year resulted from a $7 million decrease in first quarter
snow removal service revenue, offset in part by increased enhancement revenue
and a

23

comparable level of base contract maintenance
revenue.  Delays in the timing of new
contract maintenance sales relative to the Companys original goals also
contributed to the decline in revenue.
These factors offset the positive effects of an improvement in customer
retention and the growth in enhancement revenue.  The increase in the six month operating loss was primarily a
result of a lower level of high margin first quarter snow removal revenue.  Operating income from first quarter snow
removal decreased approximately $4 million in 2006.

Revenue for the six months in the Terminix segment
increased one percent to $561 million compared to $553 million in 2005.  Operating income increased six percent to
$93 million compared to $88 million in 2005.
As discussed in the second quarter comparison, this segments overall
revenue growth for the six months was affected by offsetting results on the
termite side of the business.  Solid
growth in termite renewal revenues resulted from improved pricing, offset in
part by a 70 basis point decline in customer retention.  The growth in termite renewal revenue,
however, was more than offset by the impact of a weak annual termite swarm.  The Company also experienced an additional
shift in mix from bait to lower priced liquid applications.  An important factor to note is that while
the Company realizes less revenue and profit from a liquid job in the first
year, the average lifetime profitability of a liquid and bait customer are
closely aligned.   Pest control revenue
increased four percent, supported by improving momentum in residential sales
and good commercial growth, as well as the impact of acquisitions.  Pest control customer retention increased 60
basis points and additional gains are expected in the second half of the
year.  The growth in operating income
primarily reflects continued favorable trends in termite damage claims expense
resulting from product and process improvements, improved sales labor
productivity and lower termite material costs, offset in part by higher fuel
prices and health insurance costs.  In
the first quarter of 2006, Terminix recorded a $2 million provision for costs
associated with site remediation at two locations.  In the first six months of 2005, Terminix recorded approximately
$5 million of incremental damage claim expense due to a correction in
estimating prior years termite damage claim reserves.

The American Home Shield segment reported an eight
percent increase in revenue for the six months to $276 million from $255
million in 2005 and a decrease in operating income to $34 million from $38
million in 2005.  Warranty contract
sales and renewals, which are reported as earned revenue over the subsequent
twelve-month contract period, increased five percent for the six months.  Much stronger growth in warranty contract
sales is anticipated in subsequent quarters, fueled in part by the increases in
real estate sales driven by the new brokerage agreement, as well as increased
consumer sales resulting from the timing of direct mail programs.  For the six months, strong growth in
customer renewals resulted from a larger base of renewable customers and a 200
basis point improvement in customer retention.
The Company is targeting further retention improvements, and continues
to invest in various service and customer satisfaction initiatives toward that
end.  Sales from the real estate channel
declined four percent in the first six months as home listings and closings were
impacted by a weakening home resale market, which was particularly acute in
California and several other states where the Company has a major
presence.  Longer term, the Company
believes this channel provides a significant opportunity to expand its geographic
presence and increase what is still a relatively low, industry-wide household
penetration rate.  As such, the Company
continues to invest in an expanded real estate sales force and related
marketing support, particularly in locations that are currently
under-penetrated.  Sales in the direct
to consumer channel declined due to the timing of certain direct mail campaigns
and lower response rates on certain programs.
The decrease in operating income reflects higher contract claim costs
resulting from hotter weather this year and incremental planned investments in
sales force expansion, market penetration and customer retention initiatives.

The Other Operations and Headquarters segment reported
revenue of $137 million for the six months, compared to $85 million in
2005.  The 2006 figure includes $43
million of revenue from InStar (acquired on February 28, 2006) for the four
month period since closing.  On a
combined basis, the ServiceMaster Clean and Merry Maids franchise operations
achieved a 10 percent increase in revenue for the six months.  The Other Operations and Headquarters segment
operating loss for the six months was ($17) million compared to a loss of ($24)
million in 2005.  Included in the six
month 2006 operating loss is the

24

restructuring charge of $10 million.  Excluding the restructuring charge, the
segment operating loss improved by $17 million, primarily reflecting favorable
trending of prior year insurance claims, the first-time inclusion of profits
from the InStar acquisition and lower support costs and savings from Project
Accelerate.

FINANCIAL
POSITION AND LIQUIDITY

Cash Flows from
Operating Activities
Net cash provided
from operating activities from continuing operations for the six months was $96
million, compared to $9 million used for operating activities in the prior
year. The increase in cash provided from operating activities from continuing
operations primarily reflects the $132 million tax payment made in 2005
relating to the 2005 IRS agreement. In February 2006, the IRS concluded the
2003 and 2004 audits of the Companys tax returns and during the six months
ended June 30, 2006, the Company made a payment of $5 million to the IRS and
various states.  Excluding the impact of
these two tax items, six month cash provided from operating activities from
continuing operations decreased $21 million, resulting primarily from higher
working capital requirements associated with the InStar business, during
periods of rapid growth, as well as the timing of certain insurance and tax
payments.

Excluding
the impact of the IRS agreements, the Company expects full year cash provided
from operating activities to again substantially exceed net income.  This expected result reflects a solid
earnings base, businesses that need relatively little working capital to fund
growth in their operations, and significant annual recoveries of tax assets.

The
significant annual cash tax benefit that results from the recovery of tax
assets primarily is associated with a large base of amortizable intangible
assets which exist for income tax reporting purposes, but not for book
purposes. A significant portion of these assets arose in connection with the
Companys 1997 conversion from a limited partnership to a corporation. The
amortization of the tax basis will result in approximately $57 million of average
annual cash tax benefits through 2012 for which no corresponding income
statement benefit is recorded.

In
the ordinary course, the Company is subject to review by domestic and foreign
taxing authorities, including the IRS. In the first quarter of 2005, the IRS
commenced the audit of the Companys 2005 tax return, and in the first quarter
of 2006, the IRS commenced the audit of the Companys 2006 tax return. As with
any review of this nature, the outcomes of the IRS examinations are not known
at this time.

Cash Flows from
Investing Activities
Capital
expenditures increased over the prior year and included recurring capital needs
and information technology projects. The Company anticipates approximately $50
million of capital expenditures in 2006, reflecting investments in information
systems and productivity enhancing operating systems. The Company has no
material capital commitments at this time.

Acquisitions
for the six months ended June 30, 2006 totaled $116 million, compared with $24
million in 2005. This increase reflects the acquisition of InStar, a leading
direct provider of commercial disaster response and reconstruction services,
for approximately $85 million of cash.
Consideration paid for tuck-in acquisitions in lawn care and pest
control consisted of cash payments, seller financed notes and Company stock.
The Company expects to continue its tuck-in acquisition program at both
Terminix and TruGreen ChemLawn.

25

Cash Flows from
Financing Activities
Cash dividends
paid to shareholders totaled $64 million or $.22 per share for the six months
ended June 30, 2006. In August 2006, the Company announced the declaration of a
cash dividend of $.12 per share, payable on August 31, 2006 to shareholders of
record on August 14, 2006. This represents a nine percent increase from the
$.11 per share paid in last years third quarter.  While dividends are authorized and declared on a quarterly basis,
similar rates of increase over the prior year are currently anticipated for
subsequent quarters as well, reflecting managements confidence in the Companys
earnings growth prospects and the underlying strength of its cash flows.  The timing and amount of future
dividend increases are at the discretion of the Board of Directors and will
depend, among other things, on the Companys capital structure objectives and
cash requirements at that time.

In February 2006, the Board of Directors authorized
$250 million for share repurchases. This authorization replaced the unused
portion ($30 million at December 31, 2005) from the previous authorization
approved in July 2000.  The Company
completed approximately $44 million in share repurchases in the six months
ended June 30, 2006, at an average price of $12.72 per share.  There remains approximately $206 million
available for repurchases under the February 2006 authorization.  In August 2006, the Company announced its
intention to increase its targeted share repurchases for the second half of the
year to over $100 million, more than double the amount previously anticipated for
that period.  When combined with first
half activity, this would result in approximately $150 million of total share
repurchases for 2006.  The actual level
of future share repurchases will depend on various factors, including the
Companys commitment to maintain an investment grade credit rating and other
strategic investment opportunities.

Liquidity
Cash and short and long-term marketable securities totaled approximately $389
million at June 30, 2006, compared with $367 million at December 31, 2005.  Approximately $381 million of the 2006
amount is effectively required to support regulatory requirements at American
Home Shield and for other purposes. Total debt was $804 million at June 30,
2006, approximately $146 million more than the amount at December 31,
2005.  This increase reflects funding
for normal seasonal working capital needs and the first quarter acquisition of
InStar for approximately $85 million.

Approximately 64 percent of the Companys debt matures
beyond five years and 53 percent beyond fifteen years.  The Companys next significant debt maturity
is not until August, 2007.

Management believes that funds generated from
operating activities and other existing resources will continue to be adequate
to satisfy ongoing working capital needs of the Company. The Company maintains
a revolving credit facility of $500 million. As of June 30, 2006, the Company
had $105 million of borrowings outstanding under this facility and had issued
approximately $147 million of letters of credit, resulting in unused
commitments of approximately $248 million. The Company also has $550 million of
senior unsecured debt and equity securities available for issuance under an
effective shelf registration statement. In addition, the Company has an
arrangement enabling it to sell, on a revolving basis, certain receivables to
unrelated third party purchasers. The agreement is a 364-day facility that is
renewable at the option of the purchasers. The Company may sell up to $70
million of its receivables to these purchasers in the future and therefore
would have immediate access to cash proceeds from these sales. The amount of
the eligible receivables varies during the year based on seasonality of the
business and will at times limit the amount available to the Company. During
the six month period ended June 30, 2006, there were no receivables sold to
third parties under this agreement.

There have been no material changes in the Companys
financing agreements since December 31, 2005. As described in the Companys
2005 Annual Report, the Company is party to a number of debt agreements that
require it to maintain certain financial and other covenants, including
limitations on indebtedness and an interest coverage ratio. In addition, under
certain circumstances, the agreements may limit the Companys ability to pay
dividends and repurchase shares of common stock. These limitations are not
expected to be a factor in the Companys dividend and share repurchase plans in
the near future.

26

Failure by the Company to maintain these covenants
could result in the acceleration of the maturity of the debt. At June 30, 2006,
the Company was in compliance with the covenants related to these debt
agreements and, based on its operating outlook for the remainder of 2006,
expects to be able to maintain compliance in the future. The Company does not
have any debt agreements that contain put rights or provide for an acceleration
of maturity as a result of a change in credit rating.

The Company maintains two lease facilities with banks
totaling $68 million which provide for the acquisition and development of
branch properties to be leased by the Company. At June 30, 2006, there was
approximately $68 million funded under both of these facilities. Approximately
$15 million of these leases have been included on the balance sheet as assets
with related debt as of June 30, 2006 and December 31, 2005. The balance of the
funded amount has been treated as operating leases. Approximately $15 million
of the available facility expires in January 2008 and the remaining $53 million
expires in September 2009. The Company has guaranteed the residual value of the
properties under the leases up to 82 percent of the fair market value at the
commencement of the lease. At June 30, 2006, the Companys residual value guarantee
related to the leased assets totaled $56 million for which the Company has
recorded the estimated fair value of this guarantee (approximately $0.8
million) in the Consolidated Statements of Financial Position.

The
majority of the Companys fleet and some equipment are leased through operating
leases. The lease terms are non-cancelable for the first twelve-month term, and
then are month-to-month, cancelable at the Companys option. There are residual
value guarantees (ranging from 70 percent to 87 percent depending on the
agreement) on these vehicles and equipment, which historically have not
resulted in significant net payments to the lessors. At June 30, 2006, there
was approximately $264 million of residual value relating to the Companys
fleet and equipment leases. The fair value guarantee of the assets under the
leases is expected to fully mitigate the Companys obligations under the
agreements. At June 30, 2006 the Company has recorded the estimated fair value
of this guarantee (approximately $1.0 million) in the Consolidated Statements
of Financial Position.

The
Companys 2005 Annual Report included disclosure of the Companys
contractual obligations and commitments as of December 31, 2005. The Company
continues to make the contractually required payments and therefore, the 2006
obligations and commitments as listed in the December 31, 2005 Annual Report
have been reduced by the required payments. There were no significant additions
to the Companys obligations during the six months ended June 30, 2006.  Subsequent to June 30, 2006, the Company
signed a marketing agreement that contains future commitments of
approximately $14 million.

Financial Position
Receivables increased from year-end levels, reflecting the acquisition of
InStar and an increase in American Home Shield customers paying on
account.  Inventories increased from year-end levels, reflecting general
business growth and increased seasonal activity.  Prepaid expenses and other assets increased from year-end
primarily reflecting preseason advertising costs at TruGreen ChemLawn and
Terminix as well as costs of annual repair and maintenance procedures that are
performed in the first quarter at TruGreen ChemLawn. These costs are deferred
and recognized over the production season and are not deferred beyond the
calendar year end. Deferred customer acquisition costs increased, reflecting
the seasonality in the lawn care operations. In the winter and early spring,
this business sells a series of lawn applications to customers, which are
rendered primarily in March through October. These direct and incremental
selling expenses which relate to successful sales are deferred and recognized
over the production season and are not deferred beyond the calendar year-end.
The Company capitalizes sales commissions and other direct contract acquisition
costs relating to termite baiting and pest contracts, as well as home warranty
agreements. These costs vary with and are directly related to a new sale.

Property and equipment increased from year-end levels
primarily reflecting the InStar acquisition. The Company does not have any
material capital commitments at this time.

27

The increase in accounts payable from year-end levels
reflects the acquisition of InStar as well as seasonality and growth at several
of the business units. Deferred revenue increased from year-end levels,
reflecting the significant amount of customer prepayments recorded in the first
quarter (pre-season) at TruGreen ChemLawn.
Payroll and related expenses have decreased from year end levels
reflecting incentive compensation payments related to 2005 performance that had
been accrued at year-end and paid in 2006.

The Company has minority investors in Terminix.  This minority ownership
reflects an interest
issued to the former owners of the Allied Bruce Terminix Companies in
connection with the acquisition of that entity.  At any time, the former owners may convert this equity security
into eight million ServiceMaster common shares.  The ServiceMaster shares are included in the shares used for the
calculation of diluted earnings per share whenever their inclusion has a
dilutive impact.  ServiceMaster has the
ability to require conversion of the security into ServiceMaster common shares,
provided the closing share price of ServiceMasters common stock has averaged
at least $15 per share for 40 consecutive trading days.

Total shareholders equity was approximately $1.0
billion at June 30, 2006, slightly less than the balance at December 31, 2005.
The slight decrease reflects operating profits in the business offset by the
impairment loss on certain ARS/AMS properties held pending sale, cash dividend
payments and share repurchases.

Under federal tax rules, dividends are considered
taxable only when paid out of current or accumulated earnings and profits as
defined under federal tax laws.  As a
result of its December 1997 reincorporation, the Company only began generating
corporate earnings and profits for tax purposes in 1998.  Since 1998, earnings and profits for tax
purposes have been reduced by dividend payments, amortization of intangible
assets for tax reporting, deductions relating to business closures and the
timing of certain other tax-related items.
The Company currently expects that approximately 30 percent of its 2006
dividends on common stock will be taxable as dividend income for federal income
tax purposes.  This is lower than the
2005 dividend taxability of 87 percent, as well as the prior estimate for 2006,
primarily due to one-time effects of the pending dispositions of American
Residential Services and American Mechanical Services.  The 2006 estimate is subject to change,
based on the outcome of these transactions and future events.  Any portion of the dividend that is not
taxable would be treated as a return of capital and would generally be applied
to reduce the cost basis of the shares.
The Company currently expects its dividend taxability to exceed 90
percent in 2007.

BUSINESSES
HELD PENDING SALE AND DISCONTINUED OPERATIONS

Revenues from the combined American Residential
Services (ARS) and American Mechanical Services (AMS) businesses held pending
sale decreased two percent in the second quarter and increased four percent for
the six months.  During the first
quarter, the Company recorded a $(25) million after-tax impairment charge for
expected losses on the disposition of certain ARS/AMS properties held pending
for sale.  Excluding the first quarter
charge, the after-tax operating income of $2 million in the second quarter and
$1 million for the six months reflected a modest improvement in operating
results at ARS/AMS, offset by the establishment of an accrual for certain
litigation in the second quarter and the resolution of a claim related to a
business sold in prior years which impacted first quarter results.

The
assets and liabilities related to businesses held pending sale and discontinued
operations have been classified in separate captions in the Condensed
Consolidated Statements of Financial Position. Assets from businesses held
pending sale and discontinued operations have declined from year-end levels
resulting from the provision for expected losses on the disposition of certain
ARS/AMS properties.  The liabilities
from businesses held pending sale represent payables and other current
obligations and accruals of the ARS and AMS businesses as well as obligations
related to long-term self-insurance claims of businesses previously
discontinued.

28

Subsequent to June 30, 2006, the Company completed
sales of the AMS businesses to members of the senior AMS management team.  The Company is currently engaged in detailed
negotiations to sell the ARS business in a single transaction.

Forward-Looking
StatementsThe Companys Form 10-Q filing contains or incorporates
by reference statements concerning futureresults and other matters that may be deemed to be forward-looking
statements within the meaning of the Private Securities Litigation Reform Act
of 1995. The Company intends that these forward-looking statements, which look
forward in time and include everything other than historical information, be
subject to the safe harbors created by such legislation. The Company notes that
these forward-looking statements involve risks and uncertainties that could
affect its results of operations, financial condition or cash flows. Factors
that could cause actual results to differ materially from those expressed or
implied in a forward-looking statement include the following (among others):
the successful transition of a new Chairman and CEO,  weather conditions
that affect the demand for the Companys services; changes in the source and
intensity of competition in the markets served by the Company; labor shortages
or increases in wage rates; unexpected increases in operating costs, such as
higher insurance premiums, self insurance and health care claim costs; higher
fuel prices; changes in the types or mix of the Companys service offerings or
products; increased governmental regulation, including telemarketing and
environmental restrictions; general economic conditions in the United States,
especially as they may affect home sales or consumer spending levels; time,
expenses and cash flows associated with integrating, selling, or winding down
businesses; and other factors described from time to time in documents filed by
the Company with the Securities and Exchange Commission.

29

QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK

The
economy and its impact on discretionary consumer spending, labor wages, fuel
prices, self-insurance and insurance costs and medical inflation rates could be
significant to future operating earnings.

The Company does not hold or
issue financial instruments for trading or speculative purposes. The Company
has entered into specific financial arrangements, primarily fuel hedges, in the
normal course of business to manage certain market risks, with a policy of
matching positions and limiting the terms of contracts to relatively short
durations. The effect of derivative financial instrument transactions is not
material to the Companys financial statements.

In
December 2003 and January 2004, the Company entered into interest rate swap
agreements with a total notional amount of $165 million. Under the terms of
these agreements, the Company pays a floating rate of interest (based on a
specified spread over six-month LIBOR) on the notional amount and the Company
receives a fixed rate of interest at 7.88 percent on the notional
amount. The impact of these swap transactions was to convert $165 million
of the Companys debt from a fixed rate of 7.88 percent to a variable rate
based on LIBOR (8.9 percent average rate during the six months ended June 30,
2006).

The Company believes its
exposure to interest rate fluctuations, when viewed on both a gross and net
basis, is not material to its overall results of operations.  On a gross basis, the Companys adverse
exposure to rising interest rates principally relates to interest payments on
floating rate debt ($322 million at June 30, 2006) and payments on operating
leases that are tied to floating interest rates.  These operating leases consist of approximately $68 million of
funding outstanding under the Companys real estate operating lease facilities
as well as fleet and equipment operating leases (approximately $264 million in
residual value).  The Companys exposure
to interest expense based on floating rates is partially offset on a net basis
by floating rate investment income earned on its cash and marketable securities
balances.  The Company estimates that on a net basis, each one
percentage point change in interest rates would result in a change of less than
$.01 per share on an annual basis.

The
Company has several debt and lease agreements where the interest rate or rent
payable under the agreements automatically adjusts based on changes in the
Companys credit ratings. While the Company is not currently expecting a change
in its credit ratings, based on amounts outstanding at June 30, 2006, a one
rating category improvement in the Companys credit ratings would reduce pretax
annual expense by approximately $0.5 million. A one rating category reduction
in the Companys credit ratings would increase pretax expense on an annualized
basis by approximately $0.9 million.

The
following table summarizes information about the Companys fixed rate debt as
of December 31, 2005, including the principal cash payments and related
weighted-average interest rates by expected maturity dates. The fair-value of
the Companys fixed rate debt was approximately $491 million at December 31,
2005.

Expected Maturity DateThere-
  after(In millions)

2006

2007

2008

2009

2010


TotalFixed rate debt

$
19

$
61

$
12

$
25

$
8

$
359

$
484Avg. rate


5.7
%

7.1
%

7.1
%

7.8
%

7.9
%

7.5
%

7.4
%As previously discussed, the
Company has entered into interest rate swap agreements, the impact of which was
to convert $165 million of the Companys 2009 maturity debt from a fixed rate
of 7.88 percent to a variable rate based on LIBOR.

30

CONTROLS AND PROCEDURES

The Companys Chairman and Chief Executive Officer, J.
Patrick Spainhour, and the Companys President and Chief Financial Officer,
Ernest J. Mrozek, have evaluated the Companys disclosure controls and
procedures as of the end of the period covered by this report.

The Companys disclosure controls and procedures
include a roll-up of financial and non-financial reporting that is consolidated
in the principal executive office of the Company in Downers Grove, Illinois.
The reporting process is designed to ensure that information required to be
disclosed by the Company in the reports that it files with or submits to the
Securities and Exchange Commission is recorded, processed, summarized and
reported within the time periods specified in the Securities and Exchange
Commissions rules and forms. Messrs. Spainhour and Mrozek have concluded
that both the design and operation of the Companys disclosure controls and
procedures are effective.

There were no changes in the Companys internal
control over financial reporting that occurred during the Companys most recent
fiscal quarter that have materially affected, or are reasonably likely to
materially affect, the Companys internal control over financial reporting.

31

PART
II. OTHER INFORMATION

Item 1:
Legal ProceedingsThe Companys InStar Services Group (InStar)
subsidiary has received a federal grand jury subpoena arising from an
investigation being conducted by the United States Attorneys Office in the
Southern District of Florida and the Environmental Protection Agency.  The investigation relates to potential
violations of the Clean Air Act by InStar for actions by that subsidiary prior
to its acquisition by the Company on February 28, 2006.  The subpoena was received after the Company
completed the InStar acquisition.

At this stage, the Company
is unable to predict what, if any, actions may be taken by the U.S. Attorneys
Office or the Environmental Protection Agency or to assess what penalties
ultimately may be sought or what the collateral consequences of any such
actions would be.  Nevertheless, it is
possible that the federal investigation, any resulting prosecution of InStar
and any collateral consequences arising from that prosecution could adversely
affect InStars on-going business in Florida and elsewhere.  InStar is cooperating in the investigation,
which may continue for some time. The activities of the subsidiary that gave
rise to the investigation ceased upon notice of the investigation and InStar
has adopted measures designed to prevent any re-occurrence.

Based upon currently
available information about this matter, the Company believes that any
disruption to the InStar business arising from the investigation and possible
prosecution will not have a material effect on the Companys financial
condition or results of operations.

Item
1A:  Risk FactorsThere have been no material changes
from the risk factors previously disclosed in the Companys 2005 Annual Report.

Item
2: Unregistered Sales of Equity Securities and Use of Proceeds

Share Repurchases:In February 2006, the Board of
Directors authorized $250 million for share repurchases. This authorization
replaces the unused portion ($30 million at December 31, 2005) from the
previous authorization approved in July 2000.
The following table summarizes the Companys common stock share
repurchases for the three months ended June 30, 2006 under its share repurchase
authorization. Decisions relating to any future share repurchases will depend
on various factors such as the Companys commitment to maintain investment
grade credit ratings and other strategic investment opportunities.

32

Total Number
  of Shares
  Purchased

Average Price
  Paid per
  Share

Total
  Number
  of Shares
  Purchased as
  Part of Publicly
  Announced
  Plan

Approximate
  Dollar Value
  of Shares that
  May Yet be
  Purchased
  Under the
  PlanApril 1, 2006 throughApril 30,
2006




$





$
206,000,000May 1, 2006 throughMay 31,
2006




$





$
206,000,000June 1, 2006 throughJune 30,
2006




$





$
206,000,000Total




$



Item
4:  Submission of Matters to a Vote of
Security Holders

(a)
The Companys 2006 Annual
  Meeting of Shareholders (Annual Meeting) was held on May 5, 2006 in
  Chicago, Illinois.(b)
The following persons were
  elected as Class of 2009 directors:Name

Votes For

Votes Withheld

Broker Non-VotesEileen
  A. Kamerick

254,237,770

3,833,247

N/AJ.
  Patrick Spainhour

253,890,088

4,180,929

N/ADavid
  K. Wessner

252,598,755

5,472,262

N/ANo votes were cast for any
other nominee for director.  The Class
of 2007 continuing in office is: Brian Griffiths, Sidney E. Harris, James D.
McLennan and Coleman H. Peterson.  The
Class of 2008 continuing in office is:
Roberto R. Herencia, Louis J. Giuliano and Betty Jane Hess.

(c)
The shareholders voted on
  four other proposals at the Annual Meeting.
  The following table shows the vote tabulation for the shares
  represented at the meeting:33

Proposal

Votes For

Votes Against

Votes Abstained

Broker Non-VotesProposal to
approve the Corporate Performance Plan

242,308,958

13,147,501

2,614,557


N/ARatification
of Deloitte & Touche LLP as registered public
  accounting firm

253,619,470

1,912,729

2,538,816


N/AProposal
regarding annual election of directors

165,828,449

21,515,821

5,653,923


65,072,823Proposal
regarding report on use of lawncare pesticides

17,602,084

175,446,918

17,645,519


47,376,495Item 6:
Exhibits

Exhibit
  No.

Description
  of Exhibit31.1

Certification of
  Chief Executive Officer Pursuant to Rule 13a  14(a) or 15d  14(a), as
  adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 200231.2

Certification of
  Chief Financial Officer Pursuant to Rule 13a  14(a) or 15d  14(a), as
  adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 200232.1

Certification of
  Chief Executive Officer Pursuant to Section 1350 of Chapter 63 of Title 18 of
  the United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley
  Act of 200232.2

Certification of
  Chief Financial Officer Pursuant to Section 1350 of Chapter 63 of Title 18 of
  the United States Code, as adopted pursuant to Section 906 of the
  Sarbanes-Oxley Act of 200234

SIGNATURE

Pursuant to the requirements
of the Securities Exchange Act of 1934, the Registrant has duly caused this
report to be signed on its behalf by the undersigned thereunto duly authorized.

Date: August 4, 2006THE SERVICEMASTER COMPANY(Registrant)By:
/s/ Ernest J. MrozekErnest J. MrozekPresident and Chief
  Financial Officer35